TEXT-Fitch cuts China's ZTE to 'B+'; outlook stable
Feb 06 - Fitch Ratings has downgraded China-based ZTE Corporation's (ZTE) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) to 'B+' from 'BB-' and removed them from Rating Watch Negative (RWN) on which they were placed on 15 October 2012. The Outlook is Stable.
The downgrade reflects ZTE's recent profit warning for 2012, a highly competitive telecoms equipment supply industry, and Fitch's expectation that the turnaround in ZTE's operating performance, and notably a return to sustainable positive generation of cash flow from operations (CFO), could take several quarters.
In addition to these adverse market conditions, limited share in the 4G or long-term evolution (LTE) telecom equipment market in developed countries and over-dependence on its Chinese home market are weighing on ZTE's operating margins and free cash flow. The latter have been on a weakening trend since 2011. ZTE has underperformed and lagged behind major competitors, such as Huawei Investment & Holding Co., Ltd, Telefonaktiebolaget LM Ericsson ('BBB+'/Negative) and Nokia Siemens Networks, which reported improving operating performance in recent quarters, driven by higher LTE equipment and software sales and continued restructuring.
The downgrade also reflects rapid commoditisation of smartphones as a result of low-priced chipsets from upstream providers, such as Qualcomm Inc., MediaTek Inc. and Spreadtrum Communications, Inc. This has in turn increased competition in ZTE's market of low- to mid-end smartphones.
The company is now developing more advanced and expensive smartphones. However, ZTE continues to face high-profile political difficulties in the US. Most recently a patent probe was launched by the US International Trade Commission into mobile devices from four companies based in South Korea, Finland and China for wireless patent infringement. ZTE is among the four companies under investigation. Although the US market accounts for a small portion of ZTE's total turnover, it is the largest overseas market for ZTE's smartphones and the company plans to double its market share in the US by 2015.
The Stable Outlook primarily reflects Fitch's expectation of a pick-up in Chinese telecoms capex in 2013 and 2014 and an increase in overseas telecoms capex spending in 2013 after a drop-off in network equipment spending in 2012. Developed countries with established mobile networks are likely to expand their LTE coverage in 2013, and emerging markets are likely to start groundwork-related spending on LTE technology. The 4G capex cycle is an opportunity for ZTE. However, Fitch believes that the long-term success will depend on the execution of ZTE's turnaround plan.
In addition, Fitch believes that competition among vendors, including ZTE, to secure contracts for China Mobile Limited's ('A+'/Stable) 4G network trials in 2013 - based on China's own extended time division long-term evolution (TD-LTE) technology - will be intense and hence constrain a full recovery in ZTE's margins.
Fitch expects ZTE's operating EBIT to rebound in 2013 from a substantial loss in 2012 with an operating EBIT margin of around 1% and its funds flow from operations (FFO)-adjusted leverage to be above 5x. A meaningful recovery in ZTE's credit metrics is likely in 2014, at the earliest.
What could trigger a rating action?
Negative: Future developments that may, individually or collectively, lead to negative rating action include
- sustained operating EBIT loss
- sustained FFO-adjusted leverage above 6x
Positive: Future developments that may, individually or collectively, lead to positive rating action include
- sustained operating EBIT margin of 2% or above
- sustained FFO-adjusted leverage below 5x
- sustained positive CFO generation.